THE LIBERTARIAN ENTERPRISE
Number 491, November 2, 2008
"The next two to eight years
are going to suck like a Hoover"
Free Information on The Free Market
Special to The Libertarian Enterprise
Carl the Customer
Carl goes to the store and buy a candy bar he likesa GoonBar, paying his dollar or so. On the same day in Carl's town, lots of other people bought candy bars as wellsome of them GoonBars, more bought YummyBars and fewer bought DisgustoBars. In every town in the country, similar transactions occur. Some customers buy candy in bulk at a warehouse store, some pay extra in a movie theater, most buy from a grocery or convenience store. In some towns people really love DisgustoBars, but in more towns, more people like YummyBars. Every one of these people has made a decision without consulting anyone else and chosen the candy they wanted the most at that particular time, at the combination of price and convenience that best suited them at the time. If Carl gets tired of GoonBars and decides to purchase a different candy bar or even stop eating candy altogether, he certainly could do so without notice or permission.
Steve owns a convenience store. He uses a simple formula to determine what candy bars to reorder, based on a quick inventory of the shelves. He counts the candy remaining in each display and writes the amount that was sold next to that product on a reorder list that he gets every week from his local supplier. Steve's friend Stan also owns a store and they have a lot of spreadsheets to determine amount of time on the shelf and try to analyze the best use of limited display space in his store. Steve thinks that is a waste of time, but secretly wonders whether he should do the same. Stan thinks it is worth it, but often wonders if it really works for him. There are a lot of stores in their town and a lot of towns in the country and each store is making similar decisions. Any of those store owners could change they way they determine their order at any time without notice or permission.
Dan owns a distribution company. His employees hand out sheets of paper with a list of products available to the store owners in his area. He buys the products in large volumes from factories. They arrive at his warehouse in packages as large as a small car. He opens these crates and pulls out individual cases of candy bars and puts them together with other types of candy bars according to the sheets that the store owner completed when placing the order. Dan has these cases loaded into delivery trucks and his employees drive around to the stores and deliver the products. If the stores in the area collectively order few enough of a particular item, it may not longer make sense to offer that product to the stores in the future. If several stores have requested an item that is not on the list, he might begin to offer it. Dan regularly receives information about the new products that are created from the factories and may choose to offer something that has not been requested and suggest to the stores that they try it, but it is up to Dan whether to do so and up to the store owners whether to order those new products. Dan can order different products at any time without notice or permission.
Mark is the manager of a factory that makes GoonBars. On a regular basis, Mark gets requests from local distributors for large pallets of GoonBars and is responsible for making sure those orders can be filled. If he produces them too slowly, orders go unfulfilled. If he produces too quickly, the products fill the storage and may spoil before they are sold. Therefore, Mark's management of the factory determines, in large part, whether the factory is profitable for the company or not.
Eddie is an executive the company that makes many products in many factories, including GoonBars. Eddie receives reports from the managers like Mark about which products are being produced in what quantities. He also might receive reports about which products from other companies are selling well and selling poorly. Based on this information, he determines which factories should produce which products and how many people he needs to produce them at each factory. Sometimes, Eddie takes the advice of his staff and introduces a new product. That means based on the potential reward of future profit, Eddie might risk the cost of inventing and producing a new product, marketing it, giving free samples to distributors to give to the store owners in hopes that they begin to order the new product. There is no guarantee that the company will profit from the new product. The new product could lose money for the company if the customers just don't like the new product. Eddie and his staff think they have a winner and are willing to take that risk because the potential rewards make it worthwhile. Eddie can begin this process without notice or permission from anyone outside the company.
This example has been greatly simplified, since in the real world, even a small grocery store may have over ten thousand products from hundreds of suppliers. There are additional interactions between the different products. Suffice it to say that there are a lot of decisions being made at a lot of different levels in an independent manner. There is nobody in this process that knows the goals, thoughts, preferences and liklihood of change of everyone involved in this chain of decisions. Multiply that by millions of customers, stores, distributors, factories, and companies in each industry. There is no way to know or predict with perfect accuracy, but somehow, those companies and stores are able to provide the things that we need at surprisingly low prices and still make a profit.
At each level, decisions are made on the best information and analysis available to them. At no point in the process is anyone forced into decisions. At no point is anyone unilaterally obligated to anyone else. In this case, the result is that YummyBars are produced in great volume and are very profitable, GoonBars are still produced and are carried in most stores. DisgustoBars are discontinued and no longer produced at all.
These millions of decisions every day are the best way for buyers to communicate their preferences. When this all happens, we call it the free market. The free market is not a competitor to the central planning of many forms of government, but the absence of it. Since it is not coercive, there is no worry that a company will try to sell a silly product or make bad decisions because the burden of risk falls on those making the decisions. The aggregation of these tiny voluntary transactions create the outcomes that, by definition, reflect the will of the people. It works in a bottom up fashion, with the decisions of individuals affecting the decisions, success and failure of those above. At no point is coercion necessary. If something is priced too high, the market will reject it. If it is priced too low, the market will exhaust the supply as the demand gets higher.
The relationship between risk and reward encourages those that would try new things. The profit motive encouages those that are willing to take risks to do so. This results in competition for profit and better products at better prices for customers. Nothing is forced on anyone and nobody pays for others' bad ideas.
Often in articles unfavorable to the free market the author suggests that the free markets are "inefficient" or "irrational." Those claims rest on a false premise that it is reasonable to define free market outcomes in advance based on arbitrary wishes and judge the free market on whether those targets are hit. The nature of the free market, based on lack of coercion and only voluntary transactions, is that it renders arbitrary targets like these invalid. In this example, it is easy to see that setting arbitrary goals in a top down fashion are doomed to fail. There are millions of participants and the freedom to make choices is what drives the free market and, in fact, the health of the economy of the country. To state that the free market "should have" done this or that, is silly because the free market is not an entity that takes direction, but the collection of millions of tiny voluntary decisions made in an independent manner.
So far, we have looked at the millions of voluntary unrelated decisions and come together to communicate a surprising amount of information, resulting in a free market and have limited the discussion to candy bars. There is usually less emotion surrounding examples involving candy bars than other products, so let's discuss some arguments against the free market using some harder examples.
Failures of the Free Market?
The free market is not an entity that can be defined, but instead is made up of millions of independent decisions made by individuals as they go about their daily lives. Many point to this uncontrolled nature of the free market as dangerous. Others have opinions about the goals that people "should" have and worry that they do not have them. Still others set arbitrary targets that they think the market should produce and point to the failure to hit those targets as failure of the market. Of course, the free market represents results from bottom up decisions, not a cause through top down intentions. For that reason, the free market cannot "fail," but can only produce results that are different from what some believe are "correct." More specifically, these people often assert that the free market is "unfair" or "irrational" or cannot handle "essential" products.
The most popular example of the "unfair" free market is wages. Labor is a product like any other. If Mark, the manager of the factory needs work done, he can offer a job. Willie is a potential worker that would like a job. Mark and Willie will try to negotiate an agreeable arrangement. If they come to terms, Willie accepts the job and Mark hires him. If Mark offers too little, Willie will not take the job and will go elsewhere and find a better job. If Willie asks for more than his perceived value, Mark will find somebody else that likes the rate he is offering. It is entirely possible that Willie cannot find a job at his desired wage or that Mark cannot find anyone at his desired rate, but the important thing to understand is that the wage is based on each person's perception of value and that neither Mark nor Willie is forced to enter into a transaction against his will.
Willie accepts the job and starts work, but the wage he agreed to is not sufficient to pay Willie's bills. These may include groceries, rent and medicine or they may include entertainment, gambling, and liquorboth are irrelevant to the transaction between Mark and Willie. Once again, the wage is determined by Mark and Willie alone, mostly based on the going rate, which has been communicated to them by the millions of unrelated transactions that form the free market.
Willie tells everyone he knows that he is short on money and the story reaches a government official that is instrumental in passing a law that says the minimum that anyone can be paid is two times the rate that Willie and Mark agreed upon. At first, Willie is excitedhe just doubled his pay. However, the next day, Willie is told that he no longer has a job. He asks Mark why, since he has done a good job since joining the company, and Mark tells him that there is a new law in effect that declares the minimum wage to be more than Mark is willing to pay for the job Willie performs. Willie asks if he could keep his job if he were willing to work for the old wage and Mark tells him that it is now against the law for him to be paid the amount that he naturally commands in the free market. Willie realizes that his value as an employee has not changed, only the law regarding the price at which his labor can be sold. While the intentions may have been good when the law was passed, Willie no longer has a job and Mark no longer has a good worker; that is because the signals of the free market were ignored and overriden by government.
It turns out that the government offical was under the mistaken impression that he could magically raise the relative value of Willie's skills. However, all government can really do is pass a law and interfere with the free market that represents the best information about the relative value of different products, including Willie's labor; that is because the free market is a collection of millions of decisions, not one entity that can be directed.
A common example of the so-called "irrational" free market is the fact that the best teachers are paid less than the best athletes. Many peoples' initial reactions are that we need teachers more than we need professional athletes, so certainly any free market that favors athletes is "irrational." Once again, the free market is not a single entity that makes judgments, but instead a collection of millions of unrelated decisions.
One reason that top athletes are paid more than top teachers is because of supplythere are only a handful of top athletes in the world, but there are far more top teachers. When there is a smaller supply, the price goes up because many are bidding for the few available athletes. This can be demonstrated with the realtionship between diamonds and water. Water is absolutely necessary for life and diamonds are, for most, purely ornamental. However, since we have a lot of water, but relatively few diamonds, diamonds cost quite a bit more than water. If there was one gallon of water left in the world and one diamond, it is likely that the water would command a much higher price.
Another reason that the free market signals greater value for a top athlete is, through television and radio, he can serve many more people. Therefore, he can provide value to more people than a top teacher that teaches less than a hundred students at a time. As time goes on, there is an opportunity for top teachers to change this by teaching thousands of people at a time. This is taking place in the form of cooking shows, home improvement shows, and the new rise of shows where mechanics demonstrate how to create and fix machinery. The amount of value provided by the hosts of these shows is much greater than if the same demonstrations were given by the same people in a local seminar with thirty people in the audience.
Many people imagine a crisis where "essential" products are not provided "correctly" by the free market since some people would like them to cost less than they do now. Some products are more certainly more essential than others. In the list of essential products, one will usually find health care. In fact, some have suggested that unless every person has health care, even if the price for some must be zero, the market has failed. Since the free market is just a collection of millions of tiny unrelated decisions, a goal like that cannot really be dictated to the free market.
In spite of the history of futility, the government has decided to step in and "clean up this mess." Politicians give speeches about how great the new system will be and, at the same time, there is heavy support for this scheme from the citizens. The first thing the government does is suggest that the prices charged for medical services are too high and must be lowered. One way is to cut the price of health care by 20% by capping the amount that different types of visits can cost. Another way is to remove any barriers to using generic drugs that cost less. Although the free market has communicated the prices at which there is a sufficient supply of providers to meet the demand for services, the new government agency is sure that through force, it can gain compliance to solve the problem better. Furthermore, the government is more than willing to ignore the moral implications of using such tactics.
Dave is a doctor with a small practice. He likes providing health care, but the new rates do not permit him to keep his existing staff and still make enough money to make the hassles and stress of running a small business worthwhile. His brother offers him a job in another field and he decides to take it. He lets the patients and staff know that the practice will shut down in the near future.
The new rate caps are also noticed by students preparing for college. It becomes common knowledge that the high rewards for becoming a doctor are no longer available, which no longer justifies the amount of schooling and investment required to become a doctor. The best students start to migrate toward other professions with higher rewards.
Since different industries use similar equipment in different ways (and only medical mechinery so far has lower demand due to capped prices), companies that produce medical equipment notice the lowered demand for high tech instruments and begin to shift production to non-medical machines.
Drug companies often have high markups on their pills once they are available for sale. Many people hear that the marginal cost for manufacturing a pill is a few cents, and object to the high price of medicine. What they do not see is the incredible amount of money in research and testing leading up to the first pill; they often do not see the number of attempts that never get sold that have to be covered by the few that do; in addition, they do not see that investors choose to invest in speculative medical breakthroughs only because of the potential of high returns.
A policy of buying medicine from companies that reverse engineer medical breakthroughs that have already been invented and approved would result in lower costs in the short term. But, over a few years, most drug companies would move into other industries because investment in medicine no longer would bring rewards that make it worthwhile. There is no reason to fund research once there is little potential to profit. This results in the top scientists moving to other industries as well. Almost no new drugs are invented and no new diseases are cured.
It turns out that ignoring the signals from the free market regarding the prices of medical care, equipment, and the research involved in drugs has actually resulted in less health care of lower quality than when the free market provided it. Government may pass laws and interfere with the free market, but it does not have the power to magically change the relative value of different products, including health care.
The free market does not make value judgments, but instead collects the results of millions of unrelated decisions. On a practical note, it is the best tool we have to discern the constantly changing preferences of many individuals (society). It is also the best promulgator of signals that, if left alone, automatically warns us to dodge perilous actions that may otherwise seem "fair," "rational," or "essential." More importantly, it begins and ends with voluntary individual decisions and operates without coercion, which means it is the only moral system we have as a context for conducting any transaction that pertains to production, distribution, and use or income, wealth, and commodities.
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